Dividends used to contribute significantly to investors’ annual returns. For much of the 20th century, dividend yields on the S&P 500 (SNPINDEX: ^GSPC) floated between 3% and 5%, save for a few macroeconomic shocks (which sent yields higher). Today, a stock paying a 3% dividend could be considered a high-yield dividend stock. In fact, the S&P 500’s aggregate dividend yield over the last 12 months has fallen to 1.04%, the lowest value on record.
The last time dividend yields were this low, it didn’t bode well for investors. The S&P 500 dividend yield reached a low of 1.11% in September 2000, just six months before the dot-com bubble burst. Here’s what’s pushing today’s dividend yield lower, how low yields played out over the long run, and what it means for investors today.
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Do low dividend yields mean a crash is coming?
There are a few reasons why dividend yields have dropped significantly since the 1980s. First and foremost, fewer companies in the S&P 500 pay dividends. Instead, more companies are using excess cash to repurchase stock. In 1982, a Securities and Exchange Commission (SEC) rule change made it easier for companies to buy back their own stock, which gives management much more flexibility in capital returns.
The second factor is that Treasury yields have steadily declined (although they’ve recently recovered). Lower bond yields put less pressure on management to offer high dividend yields.
Lastly, stocks trade at a considerable premium compared to their historic average. With the S&P 500 trailing P/E ratio hovering around 29 (compared to levels well below 20 through the 1980s), paying out the same percentage of earnings as a dividend would still result in a lower yield due to higher stock prices.
That last factor may be the most concerning for investors. After all, the last time valuations climbed to similar levels and pushed dividend yields lower was practically the peak of the dot-com bubble. That said, forward P/E ratios currently sit below peak dot-com levels, and the companies leading the stock market higher sit on a solid foundation of positive earnings and cash-flowing businesses.
Do companies have a good reason for keeping dividends low?
As mentioned, one of the big reasons dividends have shrunk over the last few decades is that share repurchases have become a much more practical way to return capital to shareholders. Even after recent legislation started taxing buybacks, they’re still more tax-efficient for investors than dividends in most cases. The flexibility they provide for management to make capital investment decisions has also proved especially valuable in some cases.
